3.6. Fiscal Policy

Fiscal Policy

The set of government policies related to government spending and taxation.

Current Expenditure

Recurring government spending on day-to-day items.

Capital Expenditure

One-off government spending on physical capital.

Transfer Payments

Transfers of income between sectors of society, with no exchange of goods and services.

Expansionary Fiscal Policy

Increasing government spending or reducing taxes to increase AD.

Contractionary Fiscal Policy

Decreasing government spending or raising taxes to decrease AD.

Automatic Stabilisers

Government policies that aim to automatically stabilise short-term fluctuations in economic activity, with no change in policy.

Budget Deficit

Occurs when government spending is greater than tax revenue

Progressive Tax System

As someone's income increases, the proportion of income paid as tax increases.

Crowding Out Effect

If the government increases spending and runs a budget deficit, this will push up interest rates and crowd out some investment and consumption.

Multiplier Effect

An increase in injections in the economy results in a proportionately greater effect on aggregate demand.

Marginal Propensity to Consume (mpc)

The proportion of additional income that households spend on domestic goods and services.

Marginal Propensity to Tax (mpt)

The proportion of additional income that households pay as tax.

Marginal Propensity to Import (mpm)

The proportion of additional income that households spend on foreign goods and services.

Marginal Propensity to Save (mps)

The proportion of additional income that households save in banks.

Keynesian Multiplier

1/(1 - mpc) = 1/(mps+mrt+mpm)

Effect on AD

Effect on AD = Multiplier x Size of Injection